ANSWERS TO QUESTIONS – CHAPTER 4
2. Internal control is the process designed to ensure reliable financial reporting, effective
and efficient operations, and compliance with applicable laws and regulations.
3. Section 404 of Sarbanes-Oxley requires a statement of management’s responsibility for
establishing and maintaining adequate internal control over financial reporting by
4. The five components of COSO’s framework are as follows:
1. Control Environment. The integrity and ethical values of the company,
actions that set the tone of the organization.
2. Risk Assessment. Management’s process of identifying potential risks that
3. Control Activities. These are the activities usually thought of as “the internal
control.” They include such things as separation of duties, account
4. Information and Communication. The internal and external reporting process,
and includes an assessment of the technology environment.
5. Monitoring. Assessing the quality of a company’s internal control over time
organization.
5. The Enterprise Risk Management (ERM)-An Integrated Framework is an updated
6. A strong internal control system should have:
• Separation of duties
7. Separation of duties is the procedure whereby different individuals separately perform
8. Quality employees should have the necessary ability to perform the required task and
9. A fidelity bond is insurance that a company can purchase to protect against loss due to
employee dishonesty.
10. When employees are not required to take extended periods of leave or vacation, the
11. The procedures manual sets forth the proper procedures for processing transactions.
12. Specific authorizations generally apply to specific positions within the organization.
For example, sale of major assets can only be authorized by the board of directors,
13. The use of prenumbered documents (i.e., checks, receipts, and invoices) is a control to
14. Physical controls are designed to safeguard assets. Storerooms should be kept locked
with limited access. Serial numbers on equipment should be recorded. Unannounced
15. Independent verification of performance provides an objective evaluation. It also
16. Cash includes currency and other items payable on demand such as checks, money
orders, bank drafts, and savings accounts.
In most cases, possession equates to ownership.
18. Giving customers receipts helps to prevent theft of cash receipts. Any missing receipts
19. Control procedures over cash receipts include:
• Timely deposits.
20. Procedures that will help protect cash disbursements include making all
disbursements by check, using prenumbered checks kept in a secure place, and
reference.
21. A debit memo included with the bank statement reduces the amount of cash and a
22. Information usually contained in the bank statement includes:
• The balance of the account at the beginning of the period.
23. The bank‘s balance will be larger than the book balance if there are outstanding
24. The bank reconciliation is a schedule prepared to identify items causing differences
between the bank statement balance and the Cash account balance. Preparation of a
25. An outstanding check is a cash disbursement that has been recorded on the payer’s
not “cleared” the bank).
26. A deposit in transit is a deposit that has been recorded on the depositor’s books but
27. A certified check is a check guaranteed by a bank to be a check drawn on an account
28. The amount of a customer check that was deposited and is later found to be NSF must
29. The three elements of the fraud triangle are (1) the availability of an opportunity (2)
30. The Six Articles of the AICPA Code of Professional Conduct are listed in Exhibit 4-
4, p. 144.
SOLUTIONS TO EXERCISES – CHAPTER 4
EXERCISE 4-1
a. SOX refers to the Sarbanes-Oxley Act of 2002.
b. COSO stands for The Committee of Sponsoring Organizations of the Treadway
c. The five components of COSO’s framework are as follows:
actions that set the tone of the organization.
2. Risk Assessment. Management’s process of identifying potential risks that
3. Control Activities. These are the activities usually thought of as “the internal
statements.
4. Information and Communication. The internal and external reporting process,
and includes an assessment of the technology environment.
5. Monitoring. Assessing the quality of a company’s internal control over time
d. The Enterprise Risk Management (ERM)-An Integrated Framework is the undated
EXERCISE 4-2
1. Separation of Duties: Whenever possible, the functions of authorization, recording,
2. Quality of Employees: Employees should be competent and adequately trained to
perform the required task.
3. Bonded Employees: Employers should hire employees with high personal integrity.
4. Periods of Absence: Employees should be required to take extended vacations
and/or be rotated among duties in order to discover patterns of dishonesty or theft.
5. Procedures Manual: A procedures manual should be established, kept up-to-date,
being followed.
6. Authority and Responsibility: A clear chain of command should be established and
for specific and general authority.
7. Prenumbered Documents: The use of prenumbered documents (checks, receipts,
8. Physical Control: All assets should be properly documented, and periodically
accounted for, with access limited to authorized personnel.
EXERCISE 4-3
Some of the internal control features that should be included in the memo to Dick Haney:
• Have as much separation of duties as possible. The manager should prepare the deposit
of cash receipts collected by the sales personnel. Dick should periodically check these
• Use prenumbered documents.
EXERCISE 4-4
• Receipts should be promptly written for all cash received and the funds deposited
• Cash handling and cash record-keeping duties should be separated as well as
authorization for cash disbursements.
EXERCISE 4-5
a. The discrepancy was most likely caused by theft by Rhonda Cox, the parts department
manager. It is unlikely that sloppy recordkeeping could account for this much of a
b. Separation of duties is one internal control procedure that could have helped prevent
this type of theft. If the company was so small that it had only one employee in the
Bonding the employees would help to insure against theft loss.
EXERCISE 4-6
Separation of duties would have eliminated this problem. Jones should not have had the
EXERCISE 4-7
a. & c.
Montgomery Stationery
Statements Model
Assets
=
Liab.
+
S. Equity
Rev.
−
Exp.
=
Net Inc.
Cash Flow
Cash
+
Acct. Rec.
(a) (260)
+
260
=
NA
+
NA
NA
−
NA
=
NA
(260) OA
(c) 290
+
(260)
=
NA
+
30
30
−
NA
=
30
290 OA
b. Asset exchange.
EXERCISE 4-8
Reconciling Items
Book Balance
Adjusted?
Added or
Subtracted?
Charge for Checks
Yes
−
NSF Check from Customer
Yes
−
Note Receivable Collected by Bank
Yes
+
Outstanding Checks
No
NA
Credit Memo
Yes
+
Interest Revenue
Yes
+
Deposits in Transit
No
NA
Debit Memo
Yes
−
Service Charge
Yes
−
EXERCISE 4-9
Reconciling Items
Bank Balance
Adjusted?
Added or
Subtracted?
Certified Checks
No
NA
Petty Cash Voucher
No
NA
NSF Check from Customer
No
NA
Interest Revenue
No
NA
Bank Service Charge
No
NA
Outstanding Checks
Yes
−
Deposits in Transit
Yes
+
Debit Memo
No
NA
Credit Memo
No
NA
EXERCISE 4-10
Bank Reconciliation
Unadjusted Bank Balance 5/31/2014
$26,100
Add: Deposit in Transit
6,981
Less: Outstanding Check
(5,720)
True Cash Balance 5/31/2014
$27,361
Unadjusted Book Balance 5/31/2014
$27,350
Add: Credit Memo for Interest Earned
36
Less: Debit Memo for Service Charge
(25)
True Cash Balance 5/31/2014
$27,361
EXERCISE 4-11
Unadjusted Bank Balance, 6/30 $71,230
EXERCISE 4-12
Unadjusted Book Balance, 5/31
$7,215
Add: Interest Earned
$ 13
Note Collected by Bank
500
513
Less: NSF Check
68
Service Charges
50
(118)
True Cash Balance, 5/31
$7,610
EXERCISE 4-13
According to Article II (The Public Interest) of the AICPA Code of Professional Conduct,
an accounting professional should act in a way that will serve the public interest and honor
the public trust. Because Jessica is the sister of Mark Miller, her independence as the
EXERCISE 4-14
a. Several of the articles should be mentioned in the memo.
Article I Responsibilities
As a professional, Kato should exercise professional and moral judgment in
his position.
b. Pleading ignorance would not relieve Kato of responsibility. Article V requires that
members of the profession be competent and provide quality services.